India's RBI Lost Its Only Dove as Talk of Rate Hike Swirls
The MPC is concerned about the inflationary impact from Prime Minister Narendra Modi’s expansionary budget.
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(Bloomberg) -- Members of India’s rate setting committee are concerned about the inflationary impact from Prime Minister Narendra Modi’s expansionary budget, minutes of the February central bank policy meeting showed.
Most of the six members of the monetary policy committee turned hawkish at the Feb. 6-7 meeting, when the central bank decided to keep the benchmark repurchase rate at 6 percent. One member voted for an interest rate hike while another, known from his dovish stance, gave up his call for a cut, dashing any lingering hopes that the central bank could still ease policy in coming months.
Governor Urjit Patel said there were several upside risks to inflation, while his deputy Viral Acharya noted that if growth remains robust and inflation prints continue to be well above the target of 4 percent, a change in stance from "neutral" to "withdrawal of accommodation" might have to be considered. Another central banker, Michael Patra voted for a quarter percentage-point hike, according to the minutes published Wednesday.
The RBI’s neutral stance earlier this month brought relief to the bond market, which has endured the worst sell-off in two decades.
And with Ravindra Dholakia jettisoning his rate cut call, bond investors who are grappling with tight liquidity conditions are slowly accepting the next move will probably be a hike. The swaps market showed investors are betting the central bank will raise the key rate to at least 6.5 percent before the end of 2018.
"Fixed income markets are telling us that we have fallen behind the curve," said Patra. "The target is in danger of getting out of reach and over the next few months, the upper tolerance band is under threat. This could seriously dent the credibility of the committee’s commitment to the target," he said of inflation.
The RBI is forecasting inflation for April to September at 5.1 percent to 5.6 percent before easing to 4.5 percent to 4.6 percent for the second half of the financial year, although risks are tilted to the upside. The bank’s goal is to keep headline inflation close to 4 percent over the medium term.
The central bank expects gross value added -- a key measure of growth -- to increase 7.2 percent next fiscal year from 6.6 percent this year. Forward-looking surveys show there’s still slack in the economy though, with capacity utilization at 71.8 percent in the second quarter of 2017/18. While consumer confidence is sluggish, household inflation expectations remains elevated, underlining the RBI’s hawkishness.
Budget Pangs
Earlier this month, Finance Minister Arun Jaitley presented a budget that boosted spending in a bid to placate angry voters before next year’s general election. It also included higher procurement prices for food grains from farmers and hiked custom duties to boost domestic manufacturing.
The spending boost meant India will miss its fiscal deficit target with the budget shortfall at 3.5 percent of gross domestic product in the year ending March 31, wider than the previous 3.2 percent target. The government will aim for 3.3 percent next year rather than its earlier 3 percent goal.
"Impact of the increase in customs duty and MSP proposed in the budget on the headline inflation is again uncertain," said Dholakia.
Another MPC member Pami Dua cited the decision to raise procurement prices for farmers as a risk to inflation. This warranted "a wait and watch strategy with status quo in policy interest rate and a neutral stance is currently recommended."
"A normal monsoon along with reasonable MSP hikes may imply RBI will hold rates," said Sameer Narang, chief economist at Bank of Baroda. "However, members are prepared to raise rates if upside risks to inflation materialize."
What our economists say ...Minutes of the Reserve Bank of India’s February policy review revealed a shift to a hawkish tilt from a more balanced position in December. The minutes suggest the central bank could consider a switch from neutral to a "withdrawal of accommodation" if inflation and growth pick up in line with its outlook.-- Abhishek Gupta said in a note |
| MPC MEMBER | FEBRUARY | DECEMBER |
| Patel (slight hawk) | "There are several upside risks to inflation, especially from the staggered impact of HRA increases by various state governments; policy for arriving at the minimum support prices for Kharif crops; and the fiscal slippage as indicated in the Union Budget, which also has attendant “crowding-out” implications with regard to the cost of private domestic credit." | "Several uncertainties, especially on the fiscal and external fronts, persist. It is, therefore, important to be vigilant. Hence, I vote for status quo in the policy rate, while maintaining the stance as neutral; this allows us the flexibility to respond appropriately to incoming data." |
| Acharya (hawk) | "The next few months of inflation and growth data will be key to determining the evolution of policy rates. If growth remains robust and inflation prints continue to project headline inflation a year ahead well above the target, then a change in stance from "neutral" to "withdrawal of accommodation" might have to be considered." | "There seems little scope for accommodation or for change of stance at the present juncture. Incoming data will be key to shape the policy going forward." |
| Dua (middle) | "Fiscal deficit slippage and the slower than expected fiscal consolidation as well as the staggered impact of house rent allowance by state governments may also exert pressure on inflation." | "In the current scenario, a wait and watch strategy is recommended, with continuous monitoring of data." |
| Dholakia (dove) | "The fiscal space to accommodate future higher oil price shocks seems to be absent given the slippage in the Union budget for 2018-19. Impact of the increase in customs duty and MSP proposed in the budget on the headline inflation is again uncertain. Although there is substantial fiscal slippage by the Centre, the fiscal performance of major states needs to be watched." | "By cutting the policy rate, the domestic corporate bond market, stock market and hence investment demand could be encouraged and growth can be accelerated to bridge the output gap." |
| Ghate (middle) | "While details on the exact procurement policy are awaited, the enactment of a more elaborate procurement policy in the 2018-2019 Union Budget will put stress on state finances as well. Fiscal slippages in India are inflationary!." | "Compared to the last review, various risks are materializing around inflation becoming generalized and need to be watched carefully." |
| Patra (uber-hawk) | "The target is in danger of getting out of reach and over the next few months, the upper tolerance band is under threat. This could seriously dent the credibility of the Committee’s commitment to the target." | "It is time now to signal its end and commence the withdrawal of accommodation, consistent with the evolving stance of liquidity management." |
To contact the reporter on this story: Anirban Nag in Mumbai at anag8@bloomberg.net.
To contact the editors responsible for this story: Nasreen Seria at nseria@bloomberg.net, Ruth Pollard
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